Direct yen-yuan trade

On June 1, new currency markets opened in Tokyo and Shanghai for direct trading between the Japanese yen and the Chinese yuan. The direct trading of the two currencies has been motivated largely by the instability of the main currencies such as the U.S. dollar and the euro.

With the introduction of the direct trading between the Japanese and Chinese currencies, the system that sets yen-yuan rates via their dollar values can be skipped, thus lowering transaction costs and reducing settlement risks. While the yen-yuan direct trading can be expected to help expand trade between Japan and China and have desirable effects on the Japanese and Chinese economies, the new scheme will not have an easy path ahead.

The reliability of the U.S. dollar, which played the role as the world’s key currency after World War II, has declined in recent years as the U.S. economy’s relative strength decreased. The euro, which helped form a new economic zone, also has faced difficulties due to the sovereign debt crises in Greece and other European countries. In the meantime, trade and economic relations between Japan and China have deepened.

In 2010, China overtook Japan as the world’s second largest economy. For Japan, China is its largest trading partner.

Both Japan and China came to enjoy large trade surpluses and to hold a large amount of foreign reserves in the U.S. dollar. But they came to face a common problem — a continuing decline in the value of the U.S. currency. This situation has prompted Japan and China to start direct trading between the yen and the yuan.

So far, the yen-yuan exchange had to go through two stages — first acquiring the dollar, then changing the dollar into the other party’s currency. This requires paying fees for the two exchanges, imposing rather high costs on firms and tourists.

Direct yen-yuan trading is an advantage for Japan. Japan-China trade reached ¥27.54 trillion in 2011 and is expected to expand. But most of the trade is yen- or dollar-denominated. Yuan-denominated trade accounts for less than 1 percent. At present, the demand by Japanese firms for direct yen-yuan trading inside Japan is small. The trading will not be free from the influence of the overwhelmingly large volume of yuan-dollar trading and the Chinese government’s strict currency controls.

Although it will take a long time before yen-yuan direct trading becomes completely free, hope can be placed in China’s desire to internationalize the yuan. Japan, China and South Korea must closely discuss how to promote trading among their currencies.